When will PBGC premiums force a change in contributions?

Editorial Note: This post originally appeared on our companion blog, Fiduciary Matters, on September 20, 2016.

Some wit once observed that “despite the regular and well-documented occurrence of Fridays, they always seem to catch the British railway system by surprise.”1 And just as Friday is surely coming, so too is the day when U.S. defined benefit (DB) pension plan sponsors cannot afford to pay only the minimum required contribution into their plans. There’s no excuse for being surprised by the inevitable.

Four big questions for DB plans for 2017

There are four big questions hanging over DB plans as we approach 2017. I looked at the first a couple of weeks ago (“Is there a point where interest rates are too low for LDI to make sense?”) In this post, I’ll address the second: at what point will PBGC (Pension Benefit Guaranty Corporation)2 premiums force a change in contribution policy? We’ll turn to the other two (which concern annuity buyouts and outsourcing) in later blogs.

For many years, contribution policy was not a particularly complex issue. Few plan sponsors saw much incentive to pay more than the minimum required contribution; most simply paid what they were told to pay by the IRS.

And PBGC premiums are, in effect, a tax on not making contributions, a tax that gets larger every year. From $1 per participant when the PBGC was created, these premiums had drifted up to $35 per participant plus 0.9% of the liability shortfall by 2012, when a sharp-eyed member of Congress spotted that these premiums counted as revenue for the purpose of balancing the budget. In short order, the 35-and-0.9 became (for 2016) 64-and-3.0, rising to at least 80-and-4.1 by 2019. And even if no new increases are passed by Congress, indexation means that both of those numbers will continue to increase in line with national average earnings. That formula could even mean that given enough time, the PBGC premium to be paid each year on an unfunded liability would eventually be larger than the liability itself. Admittedly, that point is several decades away (and the existence of a per-participant cap, currently $564 in total, would act as a brake), but as current legislation stands the premiums are going to just keep rising.

“So you’re telling me that to pay back a $100,000 loan I need to pay you over 25% on top of payments we’ve already agreed to, just so you can have a fund I probably won’t ever need?”

“Yeah, sorry about that, but keep in mind I am giving you a few extra years to pay me back.”

And that 25% number may be on the low side. Justin explains: “We run these numbers for plans regularly. We generally find that if the sponsor funds based on simply the minimum requirement, then as much as 30% – in some cases even 40% – of their contributions will in effect be paid to the PBGC rather than to their plan participants. This is a grossly inefficient use of cash. And with every passing year and every increase in the premiums, that number gets bigger.”

1 I’ve tried hard, but without success, to locate a source, however apocryphal, for this quote. I must have got it from somewhere.

2 The Pension Benefit Guaranty Corporation (PBGC) is an independent agency of the United States government that was created by the Employee Retirement Income Security Act of 1974 (ERISA) to encourage the continuation and maintenance of voluntary private defined benefit pension plans, provide timely and uninterrupted payment of pension benefits, and keep pension insurance premiums at the lowest level necessary to carry out its operations.

Disclosures+

This material is not an offer, solicitation or recommendation to purchase any security. Nothing contained in this material is intended to constitute legal, tax, securities or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type.

The general information contained in this publication should not be acted upon without obtaining specific legal, tax and investment advice from a licensed professional. The information, analysis and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual entity.

Nothing contained in this material is intended to constitute legal, tax, securities or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type.

Russell Investments’ ownership is composed of a majority stake held by funds managed by TA Associates with minority stakes held by funds managed by Reverence Capital Partners and Russell Investments’ management.

Frank Russell Company is the owner of the Russell trademarks contained in this material and all trademark rights related to the Russell trademarks, which the members of the Russell Investments group of companies are permitted to use under license from Frank Russell Company. The members of the Russell Investments group of companies are not affiliated in any manner with Frank Russell Company or any entity operating under the “FTSE RUSSELL” brand.

This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments. It is delivered on an “as is” basis without warranty.

Recent Post onHelping Advisors

Disclosures+

Links to external web sites may contain information concerning investments other than those offered by Russell Investments, its affiliates or subsidiaries. Neither Russell Investments nor its affiliates are responsible for investment decisions with respect to such investments or for the accuracy or completeness of information about such investments. Descriptions of, references to, or links to products or publications within any linked web site does not imply endorsement of that product or publication by Russell Investments. Any opinions or recommendations expressed are solely those of the independent providers and are not the opinions or recommendations of Russell Investments, which is not responsible for any inaccuracies or errors.

Investing in capital markets involves risk, principal loss is possible. There is no guarantee the stated outcomes in the presentation will be met.

This is a publication of Russell Investments. Nothing in this publication is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. The contents in this publication are intended for general information purposes only and should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional concerning your own situation and any specific investment questions you may have.

Russell Investments’ ownership is composed of a majority stake held by funds managed by TA Associates with minority stakes held by funds managed by Reverence Capital Partners and Russell Investments’ management.

Frank Russell Company is the owner of the Russell trademarks contained in this material and all trademark rights related to the Russell trademarks, which the members of the Russell Investments group of companies are permitted to use under license from Frank Russell Company. The members of the Russell Investments group of companies are not affiliated in any manner with Frank Russell Company or any entity operating under the “FTSE RUSSELL” brand.

Links to external web sites may contain information concerning investments other than those offered by Russell Investments, its affiliates or subsidiaries. Neither Russell Investments nor its affiliates are responsible for investment decisions with respect to such investments or for the accuracy or completeness of information about such investments. Descriptions of, references to, or links to products or publications within any linked web site does not imply endorsement of that product or publication by Russell Investments. Any opinions or recommendations expressed are solely those of the independent providers and are not the opinions or recommendations of Russell Investments, which is not responsible for any inaccuracies or errors.

Investing in capital markets involves risk, principal loss is possible. There is no guarantee the stated outcomes in the presentation will be met.

This is a publication of Russell Investments. Nothing in this publication is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. The contents in this publication are intended for general information purposes only and should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional concerning your own situation and any specific investment questions you may have.

Russell Investments’ ownership is composed of a majority stake held by funds managed by TA Associates with minority stakes held by funds managed by Reverence Capital Partners and Russell Investments’ management.

Frank Russell Company is the owner of the Russell trademarks contained in this material and all trademark rights related to the Russell trademarks, which the members of the Russell Investments group of companies are permitted to use under license from Frank Russell Company. The members of the Russell Investments group of companies are not affiliated in any manner with Frank Russell Company or any entity operating under the “FTSE RUSSELL” brand.